My client has a simplified employee pension (SEP) IRA through his place of employment. He’s wondering if he can make a tax-free, qualified charitable distribution (QCD) from his SEP IRA?
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in South Dakota is representative of a common inquiry involving charitable IRA distributions.
Highlights of Discussion
A QCD is any otherwise taxable distribution (up to $100,000 per year) that an “eligible IRA owner or beneficiary” directly transfers to a “qualifying charitable organization.” QCDs were a temporary provision in the Pension Protection Act of 2006. After years of provisional annual extensions, the Protecting Americans from Tax Hikes Act of 2015 reinstated and made permanent QCDs for 2015 and beyond.
With tax rates dropping in 2018 as a result of the Tax Cuts and Jobs Act of 2017, taxpayers may get more “bang for their bucks” on their 2017 tax returns by completing a QCD by December 31, 2017.
Generally, IRA owners must include any distributions of pre-tax amounts from their IRAs in their taxable income for the year. Aside from the benevolent aspect of making a QCD, a QCD is excludable from taxable income, plus it may count towards the individual’s required minimum distribution (RMD) for the year, and may lower taxable income enough for the person to avoid paying additional Medicare premiums. Note that he or she would not be entitled to an additional itemized tax deduction for a charitable contribution when making a QCD. (Apart from a QCD, IRA owners who take taxable IRA distributions and donate them to charitable organizations may be eligible to deduct such amounts on their tax returns for the year if they itemize deductions (Schedule A of Form 1040). See IRS Tax Topic 506  and IRS Publication 526, Charitable Contributions  for more information.)
An eligible IRA owner or beneficiary for QCD purposes is a person who has actually attained age 70 ½ or older, and has assets in traditional IRAs, Roth IRAs, or “inactive” SEP IRAs or savings incentive match plans for employees (SIMPLE) IRAs. Inactive means there are no ongoing employer contributions to the SEP IRA or SIMPLE IRA. A SEP IRA or a SIMPLE IRA is treated as ongoing if the sponsoring employer makes an employer contribution for the plan year ending with or within the IRA owner’s taxable year in which the charitable contribution would be made (see IRS Notice 2007-7, Q&A 36 ).
Generally, qualifying charitable organizations include those described in §170(b)(1)(A) of the Internal Revenue Code (IRC) (e.g., churches, educational organizations, hospitals and medical facilities, foundations, etc.) other than supporting organizations described in IRC § 509(a)(3) or donor advised funds that are described in IRC § 4966(d)(2). The IRS has a handy online tool Exempt Organization Select Check , which can help taxpayers identify organizations eligible to receive tax-deductible charitable contributions.
Where an individual has made nondeductible contributions to his or her traditional IRAs, a special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.
Be aware there are special IRS Form 1040 reporting instructions that apply to QCDs.
Section IX of IRS Notice 2007-7 contains additional compliance details regarding QCDs. For example, QCDs are not subject to federal tax withholding because an IRA owner that requests such a distribution is deemed to have elected out of withholding under IRC § 3405(a)(2) (see IRS Notice 2007-7, Q&A 40 ).
Eligible IRA owners and beneficiaries, including those with inactive SEP or SIMPLE IRAs, should be aware of the benefits of directing QCDs to their favorite charitable organizations.